Equity Investments — The New Crowdfunding

Translating an innovative concept into a thriving business is a complicated and unpredictable proposition. Traditional banks are often reluctant to fund vulnerable startups with what they perceive as unproven ideas.

Considering the current crowdfunding boom, investing in start ups only makes sense. We discussed the impact of the crowdfunding culture in a previous post.

Since the 2012 passage of the JOBS aka Jumpstart Our Business Startups Act, which loosened longstanding federal restrictions on how and from whom companies can raise money, equity crowdfunding has been a viable option for U.S.-based startups and small businesses.

In that time, it has also become a potentially lucrative and risky opportunity for investors.

The intent of JOBS is to stimulate investment in new, emerging businesses and to relieve smaller publicly traded companies from what some feel are burdensome reporting requirement.

Under the new provisions specifically regarding crowdfunding, the JOBS Act, previously passed by as, The Entrepreneur Access to Capital Act, was amended in the Senate and allows companies to publicly solicit investors in two groups:

Investors with an annual income or net worth of $100,000 can invest up to the greater of $2,000 or 5% of their annual income or net worth.

Investors with an annual income or net worth greater than $100,000 can invest up to the greater of 10% of their annual income or net worth.

In other words, only accredited investors were allowed to invest. Companies are now able to raise up to $1 million annually. Broker-dealers sponsoring the offering must be registered with the Securities and Exchange Commission.

It gives everyone access to investment opportunities that were formerly available only to “accredited investors“— which formally was restricted to people who earn $200,000 per year (or $300,000 along with a spouse) or a net worth of $1 million, excluding their primary residence. Purchasers are required to hold any securities bought under this provision for a minimum of one year.

Advocates and policymakers now widely celebrate the launch of equity crowdfunding that permit equity investing for all Americans, not just the wealthy.

In a digital-first-world, that means creating a transparent, open process where entrepreneurs can choose which investors to take on when raising funds. For some entrepreneurs, that means finding support from “the crowd,” while for others it will mean seeking a specific few investors with relevant experience.

Still, the logistics involved with a site like Indiegogo getting into equity crowdfunding would be extraordinarily complex. “Facilitating regulated investments is very different from giving away T-shirts or hats or putting people’s names in the credits of a movie,” says Ryan Feit, CEO of SeedInvest and a founder of the Crowdfunding Professional Association. To ensure that its transactions meet SEC rules, Indiegogo might have to trade in its laissez-faire atmosphere for something a little more buttoned-down.

To be clear, equity crowdfunding surpasses the encompass of the “Kickstarter” business model. Kickstarter is a tremendous platform, bringing creative projects to life, many of which wouldnever exist otherwise.

We should call this new form of online capital raising by a more proper name other than equity crowdfunding—marketplace investing, according to other experts. Because lets be honest, a good product is more beneficial and will have the more options for raising capital.

The days of SEC managing the risk of investing in startups by restricting the practice to well-heeled individuals are over. Widespread adoption of marketplace investing will lead to dramatic change for all parties in private equity. For example–there are three parts of private equity: 1) sourcing strong new deals, 2) executing strong transactions / making good decisions and 3) adding value post-close. However, it’s hard being good at all three.

Technology forces the best players to differentiate themselves from the new better, faster, cheaper alternatives while bulldozing any and all intermediaries that can’t innovate. Private equity investing is no different. Equity-crowdfunding is nothing new.

The potential for marketplaces to create value for entrepreneurs all across the world, and bring transparency to private equity for all parties, is promising.

Keep in mind that a traditional IPO is probably the least likely exit for an angel-investment. Still, you can earn a return on your investment through other exit strategies, including management buybacks, acquisitions, and resale of shares on secondary markets(trading stock).

The emergence of equity crowdfunding is expected to spawn new, online secondary markets and/or public stock exchanges for crowdfunded equity—that is, Internet-based marketplaces where crowdfunding investors can sell their shares after a mandatory one-year holding period.

Sort of like the crowdfunding revolution, the government should let the equity-crowdfunding revolution play itself out. It’s simple. It’s either you win and see return-on-investment or you don’t.

With that being said, here are the most common ways to collect capital for any start-up (thank us later).

1. Self-Financing

2. Friends and Family

If you can’t tap your own piggy bank, or if your credit score isn’t good enough to convince a bank to lend you money, you can always turn to the people who know you best. Family members and friends can be easier to persuade than anonymous bank officials.

3. Small Business Administration (SBA) Loans / Grants

Created by Congress in 1953, the SBA doesn’t lend directly to small businesses. Instead, the SBA offers a variety of guaranty programs for loans made by qualifying banks, credit unions, and nonprofit lenders.

4. Venture Capital (VC)

Venture capital firms make direct investments in fledgling companies in exchange for equity stakes in the business.

5. Angel Investors

If you can’t get enough cash from the bank or your own assets and you don’t have a rich uncle, you can always look for a wealthy non-relative.

6. Crowdfunding

It’s great, but not as easy to as it sounds. Crowdfunding is a method of capital formation where groups of people pool money, typically composed of very small individual contributions, and often via internet platforms, to invest in a company or otherwise support an effort by others to accomplish a specific goal.